1 Gold Producer to Buy, 1 to Stay Away From
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With unemployment still running high and the Fed hinting at a need for government intervention, gold producers are likely to go nowhere but up in the near-term. Many view them as a hedge against inflation and economic "tail-risks" - macro events that would be devastating to the economy but are nevertheless highly unlikely. At the same time, only some gold producers are meaningfully undervalued. While I recommend buying shares in Barrick Gold (NYSE: ABX), I also recommend holding off from Newmont (NYSE: NEM). Below, I review the fundamentals of both.
Barrick trades at a respective 9.5x and 8x past and forward earnings with a dividend yield of 2.1%. It is 56% less volatile than the broader market and, hence, a safe stock to choose if you are concerned about a double-dip. Analysts only forecast 1.3% annual earnings growth over the next five years, which sets the bar low for outperformance. Analysts nevertheless have a $50.85 price target.
Free cash flow for the TTM ending 2Q12 was particularly weak at -$546 million, but that is no reason for the firm to trade at less than half of its historical 5-year average 21.4x PE multiple. Operating in North America, Australia Pacific, Africa, and South America, Barrick is also well diversified and not terribly exposed to political unrest. In regard to risk, Barrick has traditionally hedged against gold; but, over the last two years, it has started to remove some of those hedges - a strategy that I believe will maximize upside when the economy again shows signs of struggling, as I believe it inevitably will. Goldcorp (NYSE: GG) has remained heavily invested in gold without hedges, and the strategy has paid off. Over the last 5 years, shareholder value has soared by nearly 75%.
Going forward, I expect gold demand to rise off of mounting issues surrounding the euro zone. France, for example, seems to be interested in spending, and I think other nations will follow suit and drag up the price of gold in the process. But investors should not be dependent on just the prices of gold to make a responsible investment decision. Basic materials can be highly unpredictable, so the fundamentals have to be strong to warrant an investment in my book. As it turns out, Barrick has been able to improve margins and remains one of the most efficient producers in the field.
Unlike Barrick, Newmont is largely dependent on the price of gold. During the second quarter, management performed in-line with guidance. Exploration will meet reserve depletion and exceed reserves by 100 million oz in 2012. But the firm's production was negatively impacted by planned mill maintenance in Nevada. And now the company has lowered 2012 outlook for attributable gold production by $100 million to $5 million. Capex will also fall by $300 million due to slow development at Peru's Conga. Since the price of basic materials can move unpredictably, a good way to judge a miner is to look at production. Unfortunately, Newmont's volumes have been weak against expectations. Freeport McMoRan (NYSE: FCX) has similarly had weak production, but its failings stem more from isolated labor disruptions than long-term operational failings. Moreover, Freeport is more diversified than Newmont and is not nearly as vulnerable to fading concern over inflation.
Newmont has also come under labor and political pressures at Conga. While they extoll their supposed close relationship with the "community", said community is protesting against the company's involvement in the region. The firm made negative readjustments during the second quarter as expectations were missed and revenue fell 5% on lower copper and cold volume. That is to say, the firm did so poorly production-wise that it offset the gains from a higher gold price. I thus recommend holding out to the operational direction changes.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.